Accounting undergraduate Honors theses: Are prize linked savings accounts the solution to Arkansas?

Research study sheds additional light on Americans’ financial fragility (Lusardi). Respondents were asked about confidence in their ability to come up with $2,000 in 30 days. This figure was chosen because it represents the approximate cost of an everyday emergency, like a major car or home repair, medical expense copay or legal expense. One quarter of survey respondents stated that they certainly could not come up with this sum of money, and another 15% probably could not do so. This finding suggests that nearly half of Americans are incapable of coping with a moderate financial shock.

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Recommended Citation

Wages, McKenzie, "Are Prize-Linked Savings Accounts the Solution to Arkansas' Savings Problem?" (2018) Accounting Undergraduate

Honors Theses 35.

https://scholarworks.uark.edu/acctuht/35

Are Prize-Linked Savings Accounts the Solution to

Arkansas’ Savings Problem?

by

McKenzie Kristene Wages

Advisor: JaLynn Thomas, CPA

An Honors Thesis in partial fulfillment of the requirements for the degree Bachelor of

Science in Business Administration in

Accounting and Management Sam M Walton College of Business University of Arkansas Fayetteville, Arkansas May 11, 2018

Table of Contents

I Introduction: The Savings Crisis 3

II Prize-Linked Savings: Banking on Gambling 4

Characteristics 5

Global History 5

Prize-Linked Savings in the United States 6

III A Safe Bet for Savers and Financial Institutions in Arkansas 7

Breaking through Legal Barriers 7

A Good Fit for Arkansas Households 8

Financial Institution Considerations 9

IV Conclusion 12

Appendices 13

A U.S Personal Saving Rate (1959-2017) 13

B Wealth Estimates By Country (Mid-2017) 14

C United Kingdom Premium Bond Prizes – June 2011 15

D States with Prize-Linked Savings Legislation 16

E Poverty Rates and Average Adult Lottery Expenditures for 3 Arkansas Counties 17

References 18

I Introduction: The Savings Crisis

Personal savings is an essential ingredient for the financial stability of households and society as a whole For American households, the amount of money in the bank may define their ability to weather an unforeseen crisis, like sudden unemployment or a broken down vehicle The amount of their savings may determine whether they can afford an anticipated future event like retirement or a child’s college tuition At the macro-level, economists study the consumer

savings rate as a factor in determining overall economic health

The personal saving rate in the United States has been steadily decreasing over the last several decades, according to economic data collected by the Federal Reserve Bank of St Louis (Appendix A) This Federal Reserve Economic Data (FRED) graph shows the U.S personal saving rate, calculated as the ratio of personal savings to disposable personal income, over time Personal savings peaked at 17% in 1975, a stark contrast to the 2.5% personal saving rate

recorded at the end of December 2017 Excluding a six-month period in 2005, this rate is lower than any other time since the Federal Reserve began collecting this data in 1959 (U.S Bureau of Economic Analysis)

Americans have a long-standing global reputation for their wealth In mid-2017,

American adults had an average wealth (or the difference between one’s total assets, including savings, and one’s debts) of $388,565, according to the Credit Suisse Global Wealth Report

2017 Only Iceland, Switzerland and Australia ranked higher However, the large number of high-income Americans skews this figure – roughly 43% of the world’s millionaires reside in the United States (Shorrocks et al.) Median adult wealth of $55,876, which is more representative of the middle class, places the United States 25th in global rankings (Appendix B) Despite

Americans’ reputation for wealth accumulation, they are falling behind other world economies

A 2011 research study sheds additional light on Americans’ financial fragility (Lusardi) Respondents were asked about confidence in their ability to come up with $2,000 in 30 days This figure was chosen because it represents the approximate cost of an everyday emergency, like a major car or home repair, medical expense copay or legal expense One quarter of survey respondents stated that they certainly could not come up with this sum of money, and another 15% probably could not do so This finding suggests that nearly half of Americans are incapable

of coping with a moderate financial shock

When compared to the national average, Arkansans have an even greater issue with financial stability, as indicated by median income, poverty levels, and income inequality In

2016, the real median household income in Arkansas was $45,907, 22% less than the national median of $59,039 (U.S Bureau of the Census) The Center for American Progress measures economic security and poverty for each of the 50 states plus Washington, D.C In its 2017 report, Arkansas ranks 45th in the share of people with incomes below the poverty line, which was

$24,340 for a family of four in 2016 Talk Poverty, a project of the Center for American

Progress, reports that 17.2% of Arkansans are impoverished, according to 2016 data This

percentage is well above the U.S national poverty rate of 12.7% for the same year (Arkansas Report) Regarding income inequality, The Center for American Progress’ 2015 State of the States Report reveals that the wealthiest 20% of American households’ share of the national income is 16.4 times the amount the bottom 20% receives (West)

State-specific rates of liquid asset poverty reinforce the severity of Arkansans’ financial vulnerability The liquid asset poverty rate measures the liquid savings households have

available to cover three months of basic expenses if they experienced a sudden loss of stable income Ranking below all states but Mississippi, 48.4% of Arkansas households are liquid asset

poor, compared to the 36.8% national average In other words, about half of Arkansans would likely suffer serious hardships in the event of a financial emergency due to lack of savings

(Prosperity Now Scorecard)

Furthermore, a large number of Arkansas households are underserved by banks, and many Arkansans use high-cost, high-risk credit to pay for expenses In 2015, 9.7% of Arkansas households were unbanked, meaning that no one in the household had a savings or checking account An additional 22.7% of Arkansas households were underbanked An underbanked household has a savings or checking account, but also uses an alternative, non-bank service to meet their financial needs, like non-bank check-cashing services, money orders and loans These rates for Arkansas are higher than the national underbanked and unbanked averages of 19.9% and 7.1%, respectively (“National Survey of Unbanked and Underbanked Households”)

Nonbank financial services can be much more costly and risky than comparative services

available at banks For example, 10.3% of Arkansas households used a high-cost, high-risk form

of credit, such as payday loans, automobile title loans, refund anticipation loans, rent-to-own, and pawning, to make ends meet in 2015 (Arkansas Report) In fact, being unbanked or

underbanked may contribute to lottery play Kearney explains, “For those with few assets or who encounter other barriers – either real or psychological – to engaging in the world of traditional financial markets, a lottery ticket might fill the void of a ‘missing market’.” (Kearney et al.)

The savings problem is exacerbated by a lack of financial literacy and trust in the banking system and financial markets as vehicles to assist in wealth creation Two surveys conducted by the Consumer Federation of America and the Financial Planning Association found “More than one-fifth of Americans (21%) – 38% of those with incomes below $25,000 – think that winning the lottery represents the most practical way for them to accumulate several hundred thousand dollars.” (“How Americans View Personal Wealth”) One-quarter of Americans purchase a lottery ticket at least weekly, and half report having purchased one in their lifetime In 2014, Americans spent more than $70 billion on lottery tickets, which is more than they spent on music, movie tickets, books, sports tickets and video games combined (Cohen)

If accumulating personal savings is so crucial, why not encourage individuals to save more by raising interest rates? This solution might work if this cause and effect could occur in isolation, but the reality is that interest rates are heavily influenced by the Federal Reserve, and changing those rates creates a ripple effect across the whole economy Low interest rates

encourage borrowing and spending, and are traditionally linked to economic expansion;

conversely, an interest rate increase is correlated with low consumption and investment, rising unemployment and generally slow economic growth (“Why Do Interest Rates Matter?”) Higher

interest rates would also increase the U.S government’s debt burden A National Review article

phrased the issue this way: “The problem is that the same higher interest rates that would make saving more attractive threaten the fiscal stability of the federal government, which is the world’s largest debtor.” (Williamson) We need a more creative solution to increase personal savings rates, especially for Arkansas households

II Prize-Linked Savings: Banking on Gambling

Prize-linked savings (PLS) accounts are a potential solution to the low savings problem The effective implementation of prize-linked savings programs could incentivize Arkansans to save without requiring an increase in interest rates Prize-linked savings products have

encouraged many individuals to save more, and research has shown that they are especially attractive and beneficial for the financially vulnerable segment of the population

Characteristics

Prize-linked savings accounts (also called lottery-linked deposit accounts) are a type of savings incentive product that offer depositors an alternative payoff to the current low, yet stable, interest rates borne by traditional savings accounts: the chance to win cash prizes Combining the thrill of the lottery with the security of a savings account, PLS accounts attract unbanked and underbanked individuals into the banking system and increase overall saving in a given financial institution

Although each prize-linked savings program may vary in its specific implementation, all prize-linked savings programs have the same fundamental characteristics First, the more

depositors save, the more often they are eligible to win cash prizes (typically up to a maximum number of entries per period) Prize-linked savings programs require depositors to deposit a predetermined amount, $25 for example, in the savings account in order to be issued a digital ticket Each digital ticket represents one random chance to win Keeping with this example, for every additional $25 the saver deposits during the raffle period, they receive another ticket Prizes may be given away daily, monthly, quarterly, or annually; each individual financial

institution determines the details of the prize-linked savings programs’ structure Second, and perhaps most importantly, a PLS depositor will never lose principal This feature sets PLS

accounts apart from the lottery and other traditional gambling devices

PLS accounts capitalize on a behavioral bias of individuals’ propensity for lottery-like risk-taking to inspire the productive behavior of personal saving Many Americans play the lottery each year, even though the game offers a relatively large negative expected return – about

50 cents for every dollar gambled on the average lottery ticket (Bhattacharyya) The willingness

to engage in such games can be explained by behavioral biases where individuals tend to

overweight the occurrence of a low-probability event (Kahneman) On a Freakomomics Radio

podcast, Melissa Kearney, a top researcher of prize-linked savings in the United States, refers to this phenomenon as skewness According to Kearney, “[Skewness is] the chance of changing your life… That’s the big-win outcome that might allow you to buy a beach house or to send your kids to college.” (Dubner) The idea that your life might be totally transformed with one lucky jackpot win can be very powerful and compelling, regardless of how high the odds are stacked against you Prize-linked savings programs attempt to harness the power of skewness to motivate people to choose to save more, increasing their financial security by merging the

magnetism of winning it big with zero potential for losses

There are many recent international examples of prize-linked savings programs as well

In 1918, Sweden began to offer bonds with coupon payments determined by a lottery A

Japanese bank started offering a form of PLS account called ‘lottery linked deposit accounts’ in

1994 In a matter of days, deposits in the bank’s PLS accounts increased to around $305 million USD, leading thirteen additional banks to immediately begin offering PLS products of their own The PLS program headed by Banco Bilbao Vizcaya Argentaria, a large private bank with a presence in Spain, Argentina, Columbia and Venezuela, gives depositors the chance to win cars

in addition to cash PLS programs in Brazil and Pakistan offer a diverse array of prizes as well, including motorcycles, electronics, gold bars and travel (Kearney, et al.)

The prize-linked savings aspects of United Kingdom Premium Bonds and First National Bank’s MaMa accounts have gained the attention of behavioral economists and academics, including Peter Tufano and Melissa Kearney, two of the leading researchers of prize-linked savings Peter Tufano holds a Ph D in Business Economics from Harvard, and is acting Dean in the University of Oxford Sạd Business School Melissa Kearney is an economics professor at the University of Maryland and research fellow at the National Bureau of Economic Research

The United Kingdom’s lottery bond program provides the most-purchased PLS assets in Europe This non-taxable government bond, formally called a Premium Bond, was first offered

in 1956 Premium Bonds offer no guaranteed interest to investors Instead, the interest pool is periodically and randomly given away in the form of cash prizes, in a manner akin to a lottery

As a result, many investors don’t win a prize, but a small percent of investors win big In the U.K., 23 million depositors were holding more than £33 billion in Premium Bonds in 2006 By

2011, this had increased to more than £40 billion in bonds outstanding (Pfiffelmann) The

massive investment in these bonds contributes to a sizeable prize pool, which awards substantial prizes (Appendix C)

Another current example of global prize-linked savings is the Million a Month Accounts (MaMa) offered by First National Bank of South Africa between 2005-2008 Initially, MaMa accounts paid no interest, and First National Bank awarded one grand prize of 1,000,000 rand, along with a few 100,000, 20,000 and 1,000 rand prizes each month In September 2007 they began doubling the number of small prizes given each month At the time, the traditional savings accounts most comparable to the MaMa were paying out 4-4.75% interest (Kearney et al.) The program was very successful until its termination in March 2008, when deposits in MaMa had reached nearly approximately 200 million rand (Dubner) South Africa’s Supreme Court of Appeals ultimately ruled that it was a violation of the Lotteries Act of 1997, effectively securing the South African National Lottery’s monopoly of for-profit lotteries in the country Analysis of data from First National Bank revealed that financially vulnerable individuals have more demand for the characteristics of PLS accounts and confirmed that there was strong “unmet consumer demand…for savings products that offer the (remote) prospect of changing current wealth status, rather than incrementally building wealth with certainty.” (Cole) The relaxation of regulatory barriers in the United States over the past decade has resulted in the expansion of the body of research on the implementation and study of prize-linked savings in the United States

Prize-Linked Savings in the United States

In the United States, prize-linked savings are beginning to grow in popularity Little public policy was focused on encouraging short-term savings until the recent and gradual

enactment of various prize-linked savings legislations this decade (Tufano) When the Save to Win program piloted in Michigan credit unions in 2009, it became the first prize-linked savings program to be implemented in the U.S Over the last decade, this program and other credit union-based PLS programs have expanded to reach members nationwide More recently, a few

community banks have launched PLS programs as well

Save to Win, a PLS program for credit unions, was co-created by Commonwealth and the Michigan Credit Union League Originally called the Doorways to Dreams Fund when it was founded in 2000, Commonwealth’s mission is to “Create a stronger and more prosperous society where everyone has financial opportunity…by building innovative solutions that make people financially secure.” (Our Story) Introducing PLS accounts to the United States was a part of this

mission, an effort to draw underbanked individuals into the banking system and promote

financial security Demand for Save to Win accounts was strong in its pilot year Between the eight credit unions that participated, 11,600 accounts were opened, with a total of $8.6 million in deposits; by the end of 2010 this number had tripled to $28.2 million in deposits being held A survey of accountholders shed more light on their demographic qualities Over two thirds (67%)

of accountholders had an annual household income under $60,000, and 16% had an annual household income under $20,000 Additionally, nearly two thirds of survey respondents had not earned a college degree (Flacke)

Since 2009, Save to Win has expanded to become a national prize-linked savings

program, currently promoted by 112 credit unions in eleven states (Thelen) Commonwealth has also assisted in the development of two additional prize-linked savings programs: Wincentive Savings Accounts offered by the Minnesota Credit Union and Lucky Savers in New York Between these three programs, members of 165 participating credit unions have saved over $190 million since 2009, with an average account balance of $2,409 More than 30,000 winners have received $2.73 million in prizes since the programs’ launch It is evident that PLS programs are not only attractive to depositors, they are also making an impact on individuals who may benefit most from this type of savings vehicle Data collected by Commonwealth shows that at least 86% of accountholders are financially vulnerable, meaning they are “not regular savers, asset poor, low to moderate income, had high debt, or had no emergency savings.” (“Prize-Linked Savings in Credit Unions 2017”)

Although credit unions were first to really get behind prize-linked savings in the United States, banks are beginning to show interest in offering PLS accounts According to recent email correspondence with Commonwealth, there are three banks currently offering PLS programs in the United States: Blue Ridge Bank in Virginia (Jackpot Savings), First County Bank in

Connecticut (FirstPrize Savings) and Community Bank in Oregon (Win-Win CD), which also has branches in Washington (McGlazer 2018) Community Bank is a mid-size bank with 14 branches in Washington and Oregon Its program, Win-Win CD, is structured similarly to the credit unions’ PLS products: it is a 12-month certificate of deposit account that gives depositors additional chances to win with every additional $25 saved The Win-Win CD is an add-on certificate of deposit, which allows the owner to continue to deposit funds during the term There

is a small penalty for early withdrawal (180 days of interest at 0.1%) In 2017, Community Bank offered monthly prizes of $100 and a yearly grand prize of $1000 (McGlazer 2017) Now in its second year, the value of the monthly prizes has doubled and the grand prize has increased to

$2,500 (Moran)

III A Safe Bet for Savers and Financial Institutions in Arkansas

Prize-linked savings products have had a marked impact on savers worldwide, and they would be a good fit for Arkansas as well In 2015, state legislation authorized Arkansas banks and credit unions to offer PLS programs, so there are currently no legal barriers to

implementation What is the potential demand for and impact of PLS programs for Arkansas households, and why would PLS programs make good business sense for Arkansas financial institutions?

Breaking through Legal Barriers

Despite their worldwide presence, prize-linked savings programs are only just coming to the U.S this decade because gambling laws formerly disallowed this type of savings product

The American Savings Promotion Act, which was co-sponsored by Arkansas Representative Tom Cotton, was unanimously passed in December 2014 This legislation amended “lottery” definitions in the Revised Statutes of the United States, Federal Deposit Insurance Act, Federal Reserve Act, and Homeowners’ Loan Act to exclude “savings promotion raffles” from rules against financial institutions’ dealing with lottery tickets (United States Congress) In this

legislation, a “savings promotion raffle” is defined as “a contest in which the sole consideration required for a chance of winning designated prizes is obtained by the deposit of a specified amount of money in a savings account or other savings program, where each ticket or entry has

an equal chance of being drawn, such contest being subject to regulations that may from time to time be promulgated by the appropriate prudential regulator (as defined in section 1002 of the Consumer Financial Protection Act of 2010).” (American Savings Promotion Act)

Before the federal act was passed, prize-linked savings programs were restricted to being offered by a few state credit unions The American Savings Promotion Act essentially turned the decision of whether to allow prize-linked savings programs over to each individual state As of April 2018, 26 states, including Arkansas, have passed legislation to allow prize-linked savings programs to be offered to some extent by financial institutions in their state (see Appendix D for state-specific information) (Prosperity Now Scorecard) Months after the federal legislation was signed into law, the Arkansas Savings Promotion Act came into effect on March 30, 2015 The Arkansas Savings Promotion Act amended Arkansas Code Title 23, Chapter 47, Subchapter 2, and authorized all Arkansas banks and credit unions to conduct savings promotion raffles

(Arkansas State, Legislature)

In the three-plus years since these federal and state laws were passed, no prize-linked savings programs have been established in the state of Arkansas In fact, only over half of the states with legislation authorizing these programs have implemented a PLS program to date (“Prize-Linked Savings in Credit Unions 2017”) Given the relatively low income levels of Arkansas households, demand for prize-linked savings should be high in the state The use of these savings vehicles should bring substantial benefits to Arkansas households as a result of building savings and guarding against financial distress

A Good Fit for Arkansas Households

In the U.S., prize-linked savings accounts have been found to especially appeal to

millennials, the financially vulnerable, undereducated, and those who enjoy playing games of chance (Thelen) Demand for an innovative savings product like PLS should be strong in

Arkansas, given the low median incomes, high liquid asset poverty rates, and high levels of underbanked individuals compared to the rest of the U.S “There is a potentially large group of consumers whose savings patterns might be enhanced if given a chance, however remote, of winning a life-altering prize,” (Cole) and many Arkansans fall into this category Census data for Arkansas reveals that only 32.5% of adults from the age of 25-34 had an associate’s degree or higher in 2016 By this measurement, Arkansan young adults are the second-least educated in the nation, behind only Nevada (Arkansas Report) Arkansas began a state lottery in 2009, and current lottery participants could be drawn to PLS instruments as well It’s possible that the many individuals who believe the lottery is their most practical solution to wealth building, not perceiving the value in saving through the traditional savings products that are available, will be attracted to the PLS account because of its resemblance to gambling

When the Arkansas Scholarship Lottery Act passed in 2008, lotteries were allowed to be offered in Arkansas under the condition that they fund scholarships for state citizens In the recent decade, the popularity of the Arkansas Scholarship Lottery has established that many

Arkansans like to gamble Nearly 2 million Arkansans played the lottery in 2012, and the

average Arkansas household spent roughly $422 on tickets To put this amount into perspective, the average American household spent $418 on dairy products in the same year (Covington) In

2017, the Arkansas Scholarship Lottery collected approximately $449 million in revenue from instant and online sales together (Myarkansaslottery.com) Of this amount, $305 million was returned to ticket buyers in the form of cash prizes, and $71 million was transferred to the

Education Trust Account Unfortunately, the state’s high poverty rates reveal that many

Arkansans simply cannot afford such an expensive pursuit St Francis, Lee, and Phillips counties are the top three most impoverished counties in the state, with 31-36% of their residents (and 44-50% of their children) living in poverty (USDA Economic Research Service) Taken together, these three counties located in in the Delta Region of east Arkansas reported $7,183,764 of retail lottery revenue in 2014 (Comprehensive Annual Financial Report) Based on 2016 population estimates, this revenue signifies an average spending for the year of $171.21 on lottery tickets per adult in the tri-county region (“American FactFinder”) (Appendix E)

However beneficial the Arkansas state lottery setup may be for many college students in the state who receive lottery scholarships each year, the lottery functions as a regressive tax Even if low-income earners spend a smaller dollar amount on the lottery each year than high-income earners, the percent of their income spent is actually much higher Furthermore, state lotteries certainly earn their label as a “poverty trap”: they offer a payout lower than any other form of legal gambling, while providing a much lower rate of return than the types of assets that more affluent individuals typically invest in (Haisley) As a result, the lottery takes much more from low-income individuals who are rewarded by sparse or negative winnings, many of whom never have the opportunity to receive lottery-based scholarships for themselves Prize-linked savings accounts have the potential to help low-income and financially vulnerable Arkansans to better save for unexpected expenses

Gamblers are particularly prone to lack precautionary savings (Lusardi et al.) Thus, prize-linked savings programs may be uniquely positioned to attract savings from these

individuals, who are less likely to maintain emergency savings in the formal banking sector (Cole) When someone buys a lottery ticket, he or she may do so for the entertainment value and the opportunity to build wealth Timothy Flacke, executive director of Commonwealth, explains that prize-linked savings programs can capitalize on the lottery’s attractive qualities by

strengthening an individual’s wealth accumulation potential without sacrificing the entertainment value of the product used to get them there (Flacke)

Financial fragility is typically the most severe among those with low educational

attainment, no financial education, families with children, those who suffer large wealth losses, and the unemployed However, a large portion of Americans who are "middle class" also

perceive themselves to be financially fragile, as reflected by either an unexpectedly low financial position or high level of financial pessimism or anxiety (Lusardi et al.) This perception

effectively means that an even larger number of Arkansans could benefit from the improved financial stability that participation in a prize-linked savings program can offer

Financial Institution Considerations

While hundreds of credit unions have established successful prize-linked savings

programs over the last ten years in the United States, only three community banks are offering PLS programs in the United States today The lack of bank participation may be because banks are more hesitant than credit unions to venture out into the unfamiliar waters of prize-linked savings programs due to concerns about regulatory compliance, skepticism of the business case